How the global economic system short-changes countries like Malaysia

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The rules governing the global economy greatly favour the richest corporations and the richest 0.1% of the human population. Jeyakumar Devaraj looks at what Asean can do.

Liberalise the economy, foster international trade and bring in more foreign investment.

This is the standard advice given to developing countries by institutions such as the World Bank and the International Monetary Fund (IMF). These are held to be the major policies for developing the economy of the country. But should there be caveats to this advice, and are there limitations to these policy prescriptions?

Let’s take a closer look at the experience of Malaysia to evaluate this crucial issue.

Trade and development of colonial Malaya

The economic development of Malaya was based on trade – on the exports of raw materials to Britain.

British firms planted rubber and opened tin mines in Malaya to supply these raw materials to the industries of Britain, then the dominant industrial power in the world.

The large-scale production of rubber and timber required roads, railways, port and plenty of labour, which then required housing, food and healthcare. These requirements spurred the development of towns throughout the west coast of Peninsular Malaysia.

The Federated States of Malaya enjoyed a much faster rate of development under British colonial rule than did Sumatra under the Dutch – although Sumatra has a similar climate, was as unpopulated as Malaya, and is much larger in size. This was because Holland did not have as big an industrial sector and only a fraction of the demand for tin and rubber that Britain had.

Until the 1960s, Malaya remained the biggest exporter of rubber and tin to the West, and Malaya/Malaysia gained quite immensely from this.

[Bengal, also a British colony had a completely different experience. There, the British destroyed manufacturing – textiles and ship building – to remove competitors to British industry. And Bengal being quite densely populated was amenable to large-scale plantation development. Colonialism actually caused the economy of Bengal to regress.]

As a result, at independence, Malaya and then Malaysia had a better developed infrastructure than most of the countries in South East Asia and Africa. We also had a better developed civil service and a higher per capita income than many of the former colonies.

Limitations of commodity production

Rubber remained the largest export of Malaysia until the 1970s, when it was superseded by oil palm. Malaysia still is a major rubber producer – we now lie third, at about 1.2 million tonnes per year, or 9% of global output (Food and Agriculture Organization yearbook). Thailand and Indonesia have overtaken us in rubber production, and India is close on our heels.

The problem with rubber and other agricultural commodities is that their prices on the international markets have declined in real terms over the past 60 years. RSS1 is still trading at at RM4-RM7 per kg (2019 ringgit). It was RM2-RM4 per kg in the 1960s (1965 ringgit). [The cumulative inflation rate from 1965 to 2018 was about 450%].

Meanwhile, the prices of higher-end manufactured products have soared. A new Volvo in 1965 cost the princely sum of RM9,000. Now it would cost 40 times more in today’s ringgit.

In other words, the terms of trade have deteriorated for commodity producers. Our products have depreciated in price (in real terms) while the prices of machinery and manufactured products have gone up markedly.

Why have commodity prices remained low?

The simple answer is overproduction.

Newly independent countries in Asia and Africa needed foreign exchange to fund the import of machinery and manufactured goods to develop their countries. Producing aircraft carriers for the US or nuclear reactors for France was a bit beyond their capacity, so they opted for intensifying the production of agricultural commodities for the West and Japan.

When you have millions of smallholders producing an agricultural commodity for the world market dominated by a handful of large firms (for each commodity), you have a severe imbalance in market power.

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The buyers have the capacity to create stockpiles and thwart any effort to withhold exports in a bid to shore up the international price.

The producers were unable to form a similarly strong cartel to shore up prices. Malaysia tried intervening in the tin market in the 1980s and got its fingers badly burnt!

So, producing agricultural commodities and trading in the global market is not a successful strategy to generate wealth for the poor in developing countries.

Malaysia has roughly 1.5 million people working in the agricultural sector – rubber, palm oil, paddy, coconut, pepper and cocoa smallholders. These groups remain among the poorest in our society despite the various subsidies that the government extends to them.

Manufacturing for export as engine of development

Manufacturing for the export market was a strategy that was pioneered by Dr Lim Chong Eu in the early 1970s when he was Chief Minister of Penang.

Free trade zones were set up, land and electricity supply made available, corporate and export taxes waived and foreign firms invited into the country to produce for the export market.

Many large electronic firms from the US, Western Europe and Japan moved their production to Penang. Labour costs here were much lower and draconian Malaysian labour laws could be relied on to obstruct trade union activism.

Malaysia thus became and remains to this day the largest exporter of electronic components in the world. In 2018 the country exported RM381bn worth of electrical and electronic products, making up 38.2% of total exports (Martrade).

Unfortunately, the workers in our electronic factories are not doing well on their monthly wage of about RM1,500. Bank Negara Malaysia in its 2017 Annual report mentioned that the median wage of Malaysians was RM1,703 in 2016. The same report also said a family with two children residing in Kuala Lumpur would need a monthly income of RM6,500 to live “free of financial stress”. So a wage of RM1,500 isn’t quite enough!

Why are wages low in Malaysia?

The World Bank and the IMF keep telling us that wages in the developing world are low because our productivity is low. Therefore, according to the World Bank and the IMF we have to educate our workforce better and open up our economy to big foreign companies so that they can bring in the latest technology and boost our productivity.

But the productivity argument does not explain why a worker in Bayan Lepas, Penang, gets only RM1500 per month when a worker in California who does the same job is paid $3,750/month (RM15,000). Similar machines, almost the same technology, and similar output in terms of components produced in a day, but a 10-fold difference in wage.

Or take the case of a school cleaner. In Malaysia, they are paid the minimum wage of RM1,100 per month. In the US, a school cleaner would also get the minimum wage – $15 per hour – which works out to RM10,000 per month.

Clearly it is not a difference in productivity. Something else is at work.

Global chains and outsourcing

The manufacture of many products is now divided and spread out to different geographic locations. Research and development may take place in the US, the production of electronic components in a few other countries, the assembly of the product (eg mobile phones) in yet another country, and finally the product is shipped back to be sold in the US or the EU.

The large multinational that oversees the entire production chain is the dominant player as it has the brand name, the research and development capacity, patents to protect its technology (intellectual property rights) and most importantly, access to the consumer markets of the affluent West.

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In this set-up, the production of semiconductors, which cost X ringgit when produced in the factory in California, is outsourced to a Malaysian company, which is provided the machines and equipment by the multinational company to produce the same component.

But that component is then bought by the multinational at perhaps RM0.12 ie one eighth of the price it would have fetched in the US. If the Malaysian company makes too much of an objection, then the multinational will shift its orders to another Malaysian firm that is less demanding or to a similar company in Vietnam or Thailand.

The Malaysian firm is thus pressured to “behave” and not ask for too much as it depends on orders from the multinational for its business. In this way, the large multinational uses its dominant position in the production chain to squeeze companies in Malaysia, Thailand and Vietnam. These Asean companies then keep wages down to make some profits themselves. [An excellent exposition of this analysis with many empirical examples can be found in Imperialism in the 21st Century. John Smith. Monthly Review Press.]

This predatory behaviour on the part of multinationals is what the World Bank and the IMF are trying to cover up when they give us the drivel regarding productivity. Both in the case of trade in commodities and in the export of manufactured components, the dominant position of multinational companies have depressed the prices of the products being exported.

A lopsided international trading system that favours the largest companies – and not “low productivity” on the part of workers – is the main cause of low wages in Malaysia and other third world countries.

And every month, these developing countries are being shortchanged by the trading system in place and are losing billions of ringgit to the big multinational companies – billions that could have been used to tackle poverty issues and mitigate climate change.

‘Free trade’ agreements consolidate dominance of multinational firms

The World Bank and the IMF keep encouraging developing countries to sign up to “free trade” agreements. They are held up as the best way to increase our exports and to draw new direct investments.

But the problem with these “free trade” agreements is that they cover a lot more than trade.

The Trans-Pacific Partnership trade deal for example devotes a lot of space to:

  • protect the rights of foreign investors
    • They should have the right to invest in any sector of the economy that is open to local businessmen (“national treatment”)
    • They must be free to repatriate their profits without any restrictions
    • There should be no requirement for them to employ locals, transfer technology or source local inputs.
  • enhance intellectual property rights
    • Laws regarding patents are strengthened to benefit patent applicants
    • Criteria of “patentability” are made more lax
    • Penalties for patent infringement are raised
  • give multinational firms the right to avoid the local court process and refer their disputes with the host government to international tribunals
    • It loosely defines “expropriation” to cover actions that lower the profits of the investor
    • It gives precedence to investor profits over health and environmental issues

We were saved from this lopsided agreement by the election of Donald Trump as US President.

But the other trade agreements that are being negotiated around the world have many of the toxic clauses mentioned. It is frightening to note that several key leaders within the current Malaysian government believe that we need to sign up on these sorts of agreements to demonstrate to foreign investors that we are “business friendly”.

Limitations on using ‘social wage’ to transfer wealth to bottom 40%

Some argue that if the wages of workers cannot be raised to a reasonable level, strengthening the safety net and expanding the provision of basic necessities to the people at greatly subsidised prices would be another way of sharing the nation’s wealth with the poorest 40% of the people.

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Universal pensions, subsidised public transport, subsidised housing, better funding for public healthcare, free education at tertiary level, cash transfers to the bottom 20% of families are all ideas that will greatly reduce the financial stress on the bottom 40% of the people. But the structure of the global economy makes this idea quite difficult to attain.

It is a question of adequacy of funds. The Malaysian government already provides a “social wage” at present eg:

  • primary and secondary school education and healthcare are virtually free
  • the management of emergencies (such as fires and floods)
  • the provision of welfare payments to the very poor
  • security services

These are all largely paid for by the federal government.

But even at this modest level of expenditure on the social wage, the government is running a deficit of RM50bn or about 17% of the total budget for 2019. This has to be met by borrowing.

Federal government debt is already RM750bn or 54% of GDP, quite close to the 55% ceiling that the Malaysian government has set for itself. Interest payments on this debt take up some RM50bn annually. And we need to float new securities of about RM75bn in 2019 to roll over the bonds that are maturing this year. That is on top of the RM50bn of bonds that we need to float to cover our budget deficit for 2019 – a total of RM125bn has to be borrowed in 2019.

Of course, we could borrow more and increase overall debt. But that would lead to a downgrading of our credit status by international evaluators and to a higher cost of future borrowings (as we will need to offer a higher coupon rate for the bonds we float in the future).

Increasing corporate taxes in an environment where other Asean countries are lowering theirs would be seen by most governments as too risky. It might cause the transfer of the headquarters of big companies to locations with lower tax rates. Then profits made in Malaysia could be channelled to the new headquarters through transfer pricing. Our corporate taxes might actually go down.

Unfair terms of trade obstruct economic justice

The rules governing the global economy greatly favour the richest corporations and the richest 0.1% of the human population. These rules enable the richest corporations to grossly underpay our workers and our small farmers and thus amass huge fortunes.

But Malaysia is deeply integrated into the world economy. In 2018 our exports totalled RM998bn. This is 70% of the value of Malaysia’s GDP. So even if the international trading system is lopsided and it favours the richest multinational companies, Malaysia is not in a position to disengage from the world economy.

However, Malaysia and other developing countries which are also similarly affected need to work on challenging and reducing the imbalances in the global economy. We need to identify the mechanisms that siphon away wealth from our countries and devise policies to counter these.

For example, could Asean countries get together to stop the race to the bottom with respect to wages? Most Asean countries wish to attract foreign investment. Keeping wages down is one of the strategies all these countries use. Could we negotiate an agreement that sees all Asean countries increasing their minimum wage by 10% per year for the next five years? [They could also incorporate this in the Asean Free Trade Agreement and even add provisions for penalties in the form of tariffs if any member country did not keep to the agreed schedule to increase the minimum wage.]

This is do-able as it will not undermine the comparative advantage of any of the Asean member states vis-à-vis one another. Such a policy would not only reduce poverty in all Asean countries but also raise aggregate demand in the Asean region, creating new opportunities for businesses to invest. This in turn will generate jobs. So it truly is a win-win-win situation. But it needs to be worked on.

We also need to look collectively at the problem of tax avoidance. Big companies use transfer pricing and other accounting tricks to siphon out profits earned in developing countries to tax havens. So not only do they make huge profits from paying our workers a fraction of the value of their labour, they then have the audacity to escape paying taxes on these profits. We need to see how this particular modality can be stopped.

Remember, we have the ordinary people in the US and the EU on our side in this endeavour to rein in the super-rich. For just as they escape paying taxes in developing countries, super-rich individuals and corporations also avoid paying taxes in their home countries. This is one reason why sovereign debt in many Western countries exceeds 70% of their GDP and why the social security net is being reduced through an endless series of austerity measures. The ordinary people in the advanced countries are also getting disenchanted with an economic system that favours the super-rich.

We have a world to win. But we have to work hard and work smart!

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Phua Kai Lit
Phua Kai Lit

Good article by Dr Jeyakumar Devaraj. Just a couple of comments:

Should compare the welfare of people in different nations in terms of PPP (Purchasing Power Parity)

Another reasons for low wages in Malaysia is the legal employment of cheap labour from surrounding countries. This puts downward pressure on the wages paid to Malaysian workers. (To be a progressive nation, we must also protect foreign labour from gross exploitation by local employers).

The late intellectual Immanuel Wallerstein analysed the international system of unequal economic relations in his approach called “World-Systems Analysis”. The Wikipedia article on WSA does a good job in describing this way of looking at the world.